The deal catapults Microsoft into a high-stakes battleground whose combatants include Amazon.com Inc.,Apple Inc. and Google Inc., and also gives Barnes & Noble a lifeline to continue investing in its fast-growing digital-book business. As part of its investment, Microsoft is taking a 17.6% stake in a new subsidiary that will include the e-book division and Barnes & Noble's college bookstores unit, which operates 641 stores.

Shares of Barnes & Noble, which has struggled with a slide in traditional book sales and heavy investments in its Nook digital business, surged 52% on the news to $20.75, the highest closing price in about two years.

The tie-up with Barnes & Noble also furthers Microsoft's strategy to move beyond its Windows and Office software franchises and invest its growing cash pile in businesses—some $60 billion at the end of March—that it failed to capitalize on in recent years.

Those deals have yielded mixed results. Last year, for example, Microsoft agreed to supply the mobile operating system for smartphones sold by struggling Nokia Corp., but those products so far haven't gained a large foothold in the market. An Internet search partnership in 2009 with wounded Internet company Yahoo Inc. was designed to help Microsoft catch up to Google, though its Bing search engine hasn't gained much ground.

The software maker last year also bought Internet-calling service Skype for $8.5 billion after Google and Facebook showed early interest. That deal was the biggest acquisition in Microsoft's history and another whose payoff remains unclear.

Despite those efforts and years of acquisitions, Microsoft continues to generate more than 85% of its annual operating income from the Windows software and services, and its Office software suite.

By taking a minority stake in a new subsidiary that will market the Nook, Microsoft gains several footholds in e-reading. For starters, Barnes & Noble committed to creating a Nook e-reading app for Windows 8—a forthcoming Microsoft operating system that will be used in tablet-style hardware and PCs—and for smartphones powered by Microsoft software. The Nook, like Amazon's Kindle Fire, runs on Google's Android software.

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The companies also will share revenue from sales of e-books and other content.

Another possible benefit for Microsoft is that its software may power devices designed for electronic books, magazines and newspapers. Executives of the two companies didn't rule out the idea that future Nook devices could run Microsoft operating systems, and their contract also cites the possibility Microsoft could make e-readers.

The deal comes as technology continues to transform the book retailing landscape and the habits of readers, with devices like Amazon's Kindle and Apple's iPad offering book buying as well as reading.

Barnes & Noble was late to the field, lagging behind Amazon's Kindle by about two years. But the country's largest bookstore chain has quickly made up ground.

The company claims about 27% of U.S. e-book title sales today, with Amazon holding 60%. At the same time, Barnes & Noble's physical book business is declining, prompting the chain to devote more space to toys and games.

But investing in the e-book field has weighed on Barnes & Nobles' bottom line.

The bookseller has reported losses on its digital business, while earnings before interest, taxes, depreciation and amortization—a critical measure of profitability—fell 42% to $163 million in the fiscal year ended April 30, 2011.

Barnes & Noble hasn't had the resources to keep up with the global expansion of Amazon, which offers its Kindle e-reading apps for smartphones and tablets in more than 100 countries. The company was looking for a strategic partner to accelerate the Nook and e-book business globally, a strategy that Barnes & Noble signaled earlier this year.

"We're going to use the proceeds for an aggressive expansion program to take the Nook international," said William Lynch, Barnes & Noble's chief executive.

Microsoft's $300 million infusion in the new unit values it at $1.7 billion. That is more than double Barnes & Noble's roughly $800 million market capitalization as of Friday. After Monday's stock surge, that valuation now sits at $1.25 billion.

Microsoft's commitment also includes $180 million over three years in guaranteed revenue-sharing payments for e-book sales, and pledges of $125 million over five years to help fund international expansion.

Barnes & Noble had said in January it was exploring splitting off the Nook business. The company said Monday it is still exploring how a separation of the new subsidiary may occur, but cautioned such a move may not happen.

The alliance follows open feuding between the companies. Microsoft last year sued Barnes & Noble and the manufacturers of the Nook, charging the device infringed on Microsoft patents. Barnes & Noble shot back and said Microsoft was trying to "bully" smaller companies that used versions of Google's Android operating system, as Barnes & Noble does for the Nook.

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As part of the Microsoft investment, the two parties have settled their patent litigation, and the new subsidiary will have a royalty-bearing license under Microsoft's patents for the Nook, the companies said.

Though Amazon is the most direct rival to Barnes & Noble and Nook, Apple has emerged as a formidable player as consumers buy iPads and use them to read e-books. The research firm IHS iSuppli says Apple held 62% of what it calls the media tablet market in 2011, compared with 6% for Amazon and 5% for the Nook. Apple's influence helped prompt the U.S. Justice Department in April to sue the device maker and a handful of book publishers for allegedly conspiring to fix prices for e-books.

Google, though it doesn't make devices, has digitized content from books and has its own e-bookstore. After Barnes & Noble began exploring a possible spin off of the Nook business, one of the parties it had discussions with was Google, people familiar with the matter said. But these people added that the talks were in very early stages.

Microsoft's contract with Barnes & Noble nods at the possibility that Microsoft could make its own e-reading device, an unusual tactic if it plays out.

Unlike rivals such as Apple, Microsoft has relied mainly on partners to create hardware that runs its software, though there have been exceptions to that pattern such as the Xbox videogame unit and the company's ill-fated Zune media player. Another move by Microsoft that could be seen as competition to hardware makers—such as those planning tablet devices around Windows 8—could cause tension with the company's customers.

The Nook e-reading app could also bolster Microsoft's efforts to establish a digital storefront to market apps, e-books and other content to go along with Windows 8, which is critical for the company's plans to enter the tablet market.

James McQuivey, an analyst at Forrester Research Inc., said Microsoft could choose to embed the Nook experience into Windows, emulating the way Apple weds its iTunes online store to its hardware and software—while Barnes & Noble gets help distributing the Nook. "They each have what the other needs to be successful—if they can do it right," he said, but he added: "This isn't going to be easy."

Educational offerings are another important sidelight to the alliance. The new Barnes & Noble subsidiary also will support online sales of electronic versions of textbooks.

Earlier this year Apple unveiled a new version of its digital book store that supports textbooks, signaling that the company sees many of the same opportunities. "More and more schools will outsource campus management of digital materials, and that will enable us to add more accounts," said Mr. Lynch of Barnes & Noble.

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